Beta : A Measure of Market Risk
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kapil gargBeta : A Measure of Market Risk
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kapil gargBETA (β)
A MEASURE OF MARKET
RISK
PRESENTED
BY:-
KAPIL GARG
2K19G054
WHAT IS BETA?
Beta is a measure of the volatility or systematic risk of a security or portfolio
compared to the market as a whole.
Beta is used in the capital asset pricing model (CAPM), which describes the
relationship between systematic risk and expected return for assets (usually
stocks).
CAPM is widely used as a method for pricing risky securities and for
generating estimates of the expected returns of assets, considering both the
risk of those assets and the cost of capital.
THINGS TO KNOW ABOUT
ABOUT BETA (β)
Beta data about an individual stock can only provide an investor with an
approximation of how much risk the stock will add to a (presumably)
diversified portfolio.
For beta to be meaningful, the stock should be related to the benchmark that is
used in the calculation.
So How Beta Works?
A beta coefficient can measure the volatility of an individual stock compared to the
systematic risk of the entire market.
In statistical terms, beta represents the slope of the line through a regression of data
points.
In finance, each of these data points represents an individual stock's returns against
those of the market as a whole.
Beta effectively describes the activity of a security's returns as it responds to swings in
the market.
A security's beta is calculated by dividing the product of the covariance of the
security's returns and the market's returns by the variance of the market's returns over
a specified period.
TYPES OF BETA VALUES
1. Beta Value Equal to 1.0
If a stock has a beta of 1.0, it indicates that its price activity is strongly correlated with the market. A
stock with a beta of 1.0 has systematic risk.
2. Beta Value Less Than One
A beta value that is less than 1.0 means that the security is theoretically less volatile than the market.
3. Beta Value Greater Than One
A beta that is greater than 1.0 indicates that the security's price is theoretically more volatile than the
market. For example, if a stock's beta is 1.2, it is assumed to be 20% more volatile than the market.
4. Negative Beta Value
Some stocks have negative betas. A beta of -1.0 means that the stock is inversely correlated to the
market benchmark.
Beta in Theory vs. Beta in Practice
The beta coefficient theory assumes that stock returns are normally distributed from a
statistical perspective. However, financial markets are prone to large surprises. In
reality, returns aren’t always normally distributed. Therefore, what a stock's beta
might predict about a stock’s future movement isn’t always true.
Similarly, a high beta stock that is volatile in a mostly upward direction will increase
the risk of a portfolio, but it may add gains as well. It's recommended that investors
using beta to evaluate a stock also evaluate it from other perspectives—such as
fundamental or technical factors—before assuming it will add or remove risk from a
portfolio.
Disadvantages of Beta
While beta can offer some useful information when evaluating a stock, it does
have some limitations.
Beta is useful in determining a security's short-term risk, and for analysing
volatility to arrive at equity costs when using the CAPM.
Beta is calculated using historical data points, it becomes less meaningful for
investors looking to predict a stock's future movements.
Beta is also less useful for long-term investments since a stock's volatility can
change significantly from year to year, depending upon the company's growth
stage and other factors.
CONCLUSION
Beta is quantifiable, which makes it easy to use to work with and to communicate.
It helps us to analyze in a broad range how much your stock returns can deviate.
The past security price volatility does not reliably predict future investment
performance and therefore beta is not the perfect measure of risks.
It is an integral part of capital asset pricing theory which is used to calculate
required returns on a stock.
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